- This topic has 5 replies, 2 voices, and was last updated 1 year ago by
.
- Posts
“In questions involving specific inflation rates, taxation or working capital, the money/nominal method is usually more reliable.”- Kaplan Text
I get it why in specific rates, money method is more reliable.. But why in questions involving taxation or working capital the money method is more reliable??
When using real cash flows and discounting at the real cost of capital, the real cost of capital is calculated assuming that actual cash flows are inflating yearly at a constant rate.
However the problem with working capital is that it doesn’t inflate in the same way – at the end of the project we recover the actual working capital, not an inflated amount.
The problem with tax is two-fold. Partly that tax is based on the profit which is arrived at by taking the revenue flows less the cost flows, and they are likely to be inflating at different rates. Also, tax is usually paid one year in arrears and there is no inflation applicable during the one year delay.
Understood the tax part but didnt understand the WC part.. Kindly explain again
All working capital needed during the lion of the project are cash outflows. At the end of the projects life the total of the working capital is recovered but it is the actual cash total, not an inflated total.
I’m really sorry sir but i still dont get it
“However the problem with working capital is that it doesn’t inflate in the same way – at the end of the project we recover the actual working capital, not an inflated amount”…I understood what you said here..but how does this show that nominal method is more reliable??
If you could pls explain..sorry again
- You must be logged in to reply to this topic.